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How much to contribute to your 401K

Updated on April 18, 2013

If your company offers a 401K, then this is an excellent opportunity to save for retirement. But how much to put away for retirement? Unfortunately, I can’t give you an exact number…there are too many variable. However, I can recommend some basic principles to follow when saving via a 401K.

Advantages and Disadvantages to 401Ks

Like everything, there are both advantages and disadvantages to 401K plans. Let me sum up the advantages:

  • Tax Deferred. All savings for retirement in this plan are tax deferred. This means the contribution is taken out before taxes are paid on your paycheck. Taxes will be paid on the amount withdrawn, however.
  • Payroll deductions. Most companies will have 401k contributions taken automatically taken out as a payroll deduction. You should also get quarterly reports from the investment company
  • Employer Match. Your employer may match your contributions. A common match is 50% up to a maximum of 6% of your pay.
  • Loans are possible. Because the money in your 401k plan is yours, you may be able to borrow against it in the case of an emergency. Realize that if you do not make regular payments back into the 401k, it will be changed to a distribution and all penalties and taxes will follow.

Unfortunately, there is no free lunch; here are the disadvantages of 401Ks

  • Tax Deferred. (Yes, I know I listed this as an advantage) All savings for retirement in this plan are tax deferred. Taxes will be paid on the amount withdrawn. I much prefer the taxation method on Roth IRA’s, where taxes are taken out at the time of contribution, but no taxes are paid on gains or withdrawals.
  • Employers may at any time decide to reduce or eliminate their matching contribution.
  • Investing options. This is one of the greatest disadvantages of 401ks…many have investment options that just stink. And in most cases, you are limited to a small group of mutual funds, none of which are good performers.
  • Fees. This is what seems to get a lot of people riled up, and for good reason; this is also my biggest gripe with 401Ks. Fees can have quite an impact on your performance over time. And unfortunately, some retirement plans pass the fees on to you, and the fees can be quite large. You may find that after the fees are paid, you may have little or no gains.

My method for 401K investment

Everyone’s situation is different, so what I describe here will not work for everyone, but I think this is a good point to start. First, contribute enough to your 401K to get the maximum employer contribution. At this point, even if you would like to invest more money, stop contributing to your employer 401K. Why? Because the employer match is the greatest advantage of the 401K, and once you have maxed out the employer match, you are better off putting that money in a Roth or IRA. (Be sure to check out my post “Roth vs. Traditional IRA: What’s the difference?”)

So what to do if your company doesn’t have a 401K match? Personally, I would simply set up a traditional or Roth IRA for retirement investment. The employer match is the greatest advantage of the 401K, and without it, the advantages of the traditional and Roth IRAs far outweigh those of the 401K.

Thanks for reading this hub!

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